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S&P 100 options with European-style exercise (XEO)

There's a way to manage exposure to large-cap, blue-chip U.S. stocks - options on the S&P 100 (XEO).

Features of XEO options include:

European-style exercise. XEO options generally may be exercised only on the last
business day before expiration, and thus XEO options will be exercisable
only on the third Friday of the month (unless this is a holiday). Some
investors prefer this European-style feature, which means that XEO is
not subject to the uncertainties involved with possible early exercise.
(On the other hand, the OEX® S&P 100 options and most equity options
have an American-style exercise feature that allows option owners to
exercise at any time up to and including the last trading day before
expiration.)

Unique pricing characteristics. Because of their European-style exercise, some XEO
options might be cheaper than their OEX counterparts with American-style
exercise.

P.M. settlement.
XEO and OEX options are subject to P.M. settlement, which refers to the
use of the closing price of the index on the last trading day (usually
the third Friday) as the basis for settlements of exercises and
assignments.

Investment Power and Flexibility. XEO options may allow investors to participate in the price movement of a large segment of the domestic stock market with a single transaction. Bullish, bearish and neutral investors can all use S&P 100 options to implement their individual opinions of the S&P 100 market. XEO options can be used for profit or protection, with opportunities to adjust for changing markets.

Background on S&P 100 Options

S&P 100 options bring an added dimension to stock market investing by giving you the ability to trade and invest on an entirely different level. Instead of requiring you to focus on specific stocks, S&P 100 options allow you to trade a large segment of the domestic stock market with a single transaction.

The Standard & Poor's 100 Index is a capitalization-weighted index based on 100 highly capitalized stocks from a broad range of industries. More than one billion S&P 100 options contracts have been traded since the CBOE launched the trading of options on the OEX, the first cash-settled securities product, on March 11, 1983. On November 24, 1997, the index had a 2-for-1 split.

To provide investors with added flexibility in managing large-cap U.S. equity exposure, a number of S&P 100 options are now offered:

Since 1983 investors have used, cash-settled S&P 100 options (ticker symbol OEX, with American-style exercise) to adjust their equity portfolio exposure. More than one billion OEX options have been traded, making the OEX one of the most popular equity portfolio management tools in history.

In February 2001 options on iShares(SM) S&P 100 (ticker symbol OEF, with American-style exercise) were introduced.

In July 2001 the CBOE introduced cash-settled S&P 100 options (ticker symbol XEO) with European-style exercise. Some investors prefer this European-style feature, which means that XEO may be exercised only on the day just prior to expiration, and therefore XEO is not subject to the uncertainties involved with possible early exercise.

Bullish, bearish, and neutral investors can all use S&P 100 options to reflect their individual opinions of the S&P 100 market. You can trade index options for profit or protection, with opportunities to adjust for up, down or unchanging markets. The S&P 100 has established itself firmly as an active investment tool. This popularity stems from four fundamental reasons for using the broad market-based S&P 100:

Simplicity
Investors are able to trade a broad market by making one S&P 100 trading decision rather than making the many decisions involved with investing in numerous individual stocks.

Insurance
S&P 100 options offer a convenient and easy way to reduce the market risk of a broad market portfolio, without disrupting the make-up of the portfolio.

Predetermined Risk
S&P 100 option purchasers risk only the premium they pay for the option. The risk is both known and limited.

Leverage
Purchasing S&P 100 options, instead of buying or selling numerous individual stocks, provides an investor with an additional opportunity to use investment capital elsewhere. For a relatively small percentage gain in the underlying index, an S&P 100 option can increase in value by a multiple of that gain, assuming the correct option series was selected.

Margin
CBOE Regulatory Circular RG15-183 notes that CBOE rules allow a short position in a cash-settled-index option established and carried in a margin account to receive covered margin treatment, if the short option position is offset in the same account by an equivalent position in an index-tracking ETF that is based on the same index that underlies the short option(s).

In order to receive covered margin treatment, the market value of the offsetting ETF position must be equivalent or exceed the current aggregate index value of the option being covered. One should note that not all ETFs are managed so as to maintain a share price that is a constant fraction (e.g., 1/10 th, 1/100 th, 1/1,000 th, etc.) of the index being tracked.